May 27, 2024
All the chatter about the market flying high might cause lots of happiness…or it might cause a lot of worry.
Three decades ago, the Dow Jones Industrial Average was at 3,700, the S&P 500 was at 458, and the Nasdaq Composite Index was at 722. There have been a few bear markets along the way, but today those indexes are 10 times more valuable (or more).
I’ve learned that day-to-day market moves didn’t matter unless I needed my money for income or some other major expense. When you’re forced to sell in down markets, it can be stressful.
A large body of research shows 70% of decisions are based on emotional factors and 30% are based on rational factors. You can throw finances into that bucket.
Emotional investing is when emotions influence investment decisions. “Buy low, sell high,” is a simple concept and one of investing’s most basic tenets. Yet, evidence shows many people suffer from bad investment performance due to emotion.
Here are some ideas to keep your financial emotions in check.
First, remember your overall goals. This helps keep your eyes on the prize.
Next, what is your time horizon? This will influence your choices and reactions to down markets. Losses today don’t matter much if you don’t need the money for 20 years.
Third, your investment allocation should consider your risk tolerance and investing knowledge. You need to know how investments work and when you can get your money back.
Fourth, keep a long-term focus and avoid prioritizing current market noise. A way to help is to diversify your portfolio with non-correlated investments to help reduce volatility and its associated emotions.
Finally, you need liquid cash reserves to provide a sense of comfort during turbulent times and prevent selling in down markets. How much? One rule of thumb is to keep enough to cover three to six months of expenses. Some people want to have enough for three to five years of expenses. The choice is based on your own comfort level. Ask yourself how much you need to help you sleep at night, even if your investments drop in value.
Following these guidelines won’t guarantee success, but it will help you keep your financial emotions in check.